Macro Insights Weekly: Assessing market volatility markers
- First: freight rates. Moving good to the US remains costly, but China’s demand has waned
- Second: commodities. Oil is sending major inflation impulse, but gold market says no panic
- Third: inflation markers. Inflation to remain high through April; expectations still in check
- Fourth: equity market valuation. Rising yields have dimmed the prospect for growth stocks
- Fifth: USD. Dollar strength may be needed for US inflation to be tamed, but that’s bad news for EM
High inflation and policy response, ongoing and forthcoming, have made the markets nervous. So far, the nervousness has translated into some curve flattening, as stronger near-term policy action is priced in; it has also been reflected in general strength of the USD, and a pick-up in equity market stress. Still, DM credit spreads are well behaved, there is no sign of liquidity premiums rising, and EM asset prices have been only mildly under pressure.
Navigating through these uncertain times entails help from a set of indicators that give ample cues to the way markets and economies would be heading. First in this list is symptomatic of the challenges of moving goods during the pandemic—freight rates. The cost of moving good from China to the US soared last year reflecting port congestions, shortage of workers and containers, and a spike in demand. Freight rates have come down a tad over the last three months, but are still very high by historical comparison. More progress in port bottleneck easing is expected, so the worst in this area may well be over.
Moving goods to the US is expensive, but what should we take away from the plunging Baltic Dry freight rate? In the past, this indicator has been our bellwether for China’s commodity demand, which by extension is a proxy for China’s industrial production, which in turn is an indicator for global demand for manufactured goods. This weakness is important to keep in mind while considering the outlook.
Second indicator that does and could contribute to global economic and market volatility is commodity prices. Looking at oil, there seems reason to worry, as the crude price of USD90plus per barrel sends a strong inflationary impulse through the global economy. Despite the pledge by Opec+ nations to increase production (modestly), geopolitical tension on Ukraine and Iran appears to be keeping bullish sentiments intact in the oil markets. We are looking for de-escalation in the Russia-West standoff over Ukraine, and expecting to read about US Shale producers ramping up production, as that ought to put a lid on the oil market’s upward march.
Among other commodities, gold has been interesting, not showing any major movement despite a great deal of news on inflation. Perhaps inflation expectations are not yet strong enough to cause a rush to hedge. Inflation expectations indicators, another important gauge, show the same.
So then why worry? Will coming months bring about a decline in inflation rates? We doubt it, especially for the US and EU. Our inflation momentum measure shows plenty of pipeline pressure over the next three months, at least.
High inflation pushes up rate hike expectations; they also push up interest rates at the long-end. These are negative for growth stocks, which has already played out in the US stock market. We expect elevated VIX.
A strong dollar may be essential for the US to fight imported inflation, and may well to rise with rate hikes, but that is bad news for emerging markets that rely on USD funding. This indicator is as important as any other for near-term assessment of market volatility.
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